7/29/2009 @ 12:00AM

The Soaring Twenties

It’s not surprising that there has been a resurgence of interest in the economics of the Great Depression–and not just because of the economic meltdown we’ve experienced over the past months. So much of what happened back then shaped economic policy, financial markets and even the way we thought about the economy for decades to come. Equally important, however, and much less discussed, is the decade prior to the Great Depression. This was a period of remarkable transformation, both economic and social. That the decade gave rise to a number of misguided policy responses (by both the Hoover and Roosevelt administrations) says a lot about how little influential people at the time understood what was driving that transformation.

The 1920s were a period of dramatic technological change that transformed the fundamental structure of the economy, altered the nature of the family and challenged the social norms of the 19th century. I stress technology, because it was technological change that improved the economic welfare of many. So it is a mistake, a hyperbolical gesture, to view the 20s as one of those regular episodes of excess that seem to mark American economic life. When the Depression hit, a lot of the policy responses were aimed at trying to turn back the clock–not on excess, but on the changes brought by technology. Those attempts failed because it was all but impossible to do.

The technological revolution of the 1920s was driven by the continued development and widespread adoption of the internal combustion engine, the development of electrical machinery and the spread of electrification to households and manufacturing. This great transformation led to a rise in productivity in the agricultural sector that remade society. It changed productivity in the household, and altered fundamentally the size and organization of households and the lives of women. And it improved productivity in the manufacturing sector to an extent that raised living standards for many and changed both the rewards, and the nature, of work.

By the early 1920s, the agricultural sector in the U.S. was suffering. Productivity in agriculture had increased throughout the period of the First World War as American farmers increased their yields with more intense cultivation aided by gasoline-powered tractors. The increasing mechanization of agricultural production meant that a farmer who required 40 to 50 hours of labor to grow 100 bushels of wheat in 1890 could do it with only 15 to 20 hours by 1930.

The increased productivity and yields meant that prices were depressed and rural incomes suffered. Many farmers faced foreclosure because of debts they had incurred to expand and mechanize. The problems in the agricultural sector provided further impetus for the rural-urban migration that was already underway.

Technology also had a profound impact on household production–the set of tasks that are necessary to run a household and maintain a family. In 1907, only 8% of households had electricity. By 1930, 68.2% were electrified. There were also corresponding increases in the availability of central heating, running water and indoor plumbing. These innovations made possible the adoption of new technologies for household production–washers, electric irons, refrigerators and so on. The effect of these changes on the household have been studied by Jeremy Greenwood and his co-authors. They were dramatic. In 1900, they estimate, household production required 58 hours a week. By 1975 the estimate is 18 hours per week. By liberating women from much of the drudgery of basic household work, these innovations increased the time available for leisure, education and for work in the market sector. These changes, together with the shift from a rural to an urban economy, caused changes in the size of families.

The most dramatic productivity changes were in the manufacturing sector. The introduction of electrically driven machinery to the manufacturing process had dramatically accelerated productivity in the 1920s. By 1929, more than 70% of the industry was powered by electricity. The iconic symbol of this productivity boom was the Model T Ford which, by 1928, rolled off the assembly line every 10 seconds. Before World War I, a Ford would cost the equivalent of two years’ wages for the average worker. By the late 1920s it took about three months’ earnings.

The increased productivity increased incomes and led to the mass production of automobiles, consumer durables, the radio, motion pictures and many other things that changed the nature of everyday life. Household credit expanded to facilitate the purchase of all these new durable goods.

Along with the rise in productivity in the manufacturing sector, so, too, was there a rise in the compensation of executives. The data tend to be somewhat anecdotal, but suggest that executive compensation rose sharply in the 1920s and that incentive-based compensation in the form of bonuses and stock ownership became more common. And there were some excesses. One case that provoked public outrage was that of Eugene Grace, the president of Bethlehem Steel, when it was revealed that he received a base salary of $12,000 and a bonus of more than $1.6 million in 1929. Even Babe Ruth provoked a bit of a backlash by holding out for a higher salary in 1930–all of $80,000. When asked why he should be making $5,000 more than President Hoover, he reportedly replied, “I’m having a better year than he is.”

The increase in the rewards to skilled labor and the returns to ability led inevitably to a rise in inequality. It is one of the well-known characteristics of technological revolutions that a different set of skills are required. The rewards that accrue to the people who have those skills lead to a rise in inequality. As I reported a few weeks ago, the share of income earned by the top 10% peaked at close to 50% in 1928. It did not reach that level again until 2006.

This is a cursory account of what happened during what was a great decade of economic progress. There are some striking parallels to the decade preceding our recent financial crisis. The policy responses that created the most trouble in the 1920s and 1930s–that made the Depression “great”–were those that tried to undo the inevitable consequences of technological progress: trying to keep prices from falling, trying to keep wages high, and demonizing those who gained great wealth from the revolution in technology.

Let’s hope we have learned that we need to understand what got us here and not simply try to turn back the clock. Let’s also hope we have learned to dig deeper into the facts behind economic change, rather than revert to catchy but insubstantial slogans. Had Roosevelt understood the issues surrounding technology and social transformation more clearly, perhaps we wouldn’t have the Great Depression as an economic bogey to react against today.